Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Thursday, 30 October 2014

Summary:
Their basic mistake is that they think that upping bank capital requirements
involves costs. It doesn’t: as the Modigliani Miller theory explains, changing the
way a bank is funded (e.g. changing the mix of capital versus depositors versus
bond-holders, etc) has NO EFFECT ON the cost of funding a bank.

_______

It
is now widely recognised that that amount of bank capital was too low prior to
the recent crisis, and after millions of hours of haggling those capital
requirements are being raised a small amount.

Of course
banks have resisted that change with a variety of totally dishonest and not
even desperately clever arguments. I wouldn’t expect bankster / criminals and
psychotics to do otherwise.

However,
regulators and several household name economics commentators like Martin Wolf
have been happy to concede that banks DO HAVE SOME SORT OF POINT. That is, they’ve
gone along to some extent with the idea that increasing capital requirements
comes at a price. Thus we supposedly cannot go wild and impose a 50% or 75+%
capital requirement. For example Martin Wolf advocates 25%, which is way above
the percentage advocated by Vickers, Dodd-Frank, etc.

However
he says,
“I accept that leverage of 33 to one, as now officially proposed, is
frighteningly high. But I cannot see why the right answer should be no leverage
at all. An intermediary that can never fail is surely also far too safe.”

Well
the simple answer to that is that if it costs nothing to make something totally
fail safe, why not do that? I.e. the CRUCIAL QUESTION is whether raised capital
requirements cost anything.

Here’s
why they don’t.

Deposits
versus capital.

Take
two hypothetical banks: one is funded ENTIRELY BY shares, and the other
ENTIRELY BY depositors. But in other
respects the banks are the same: in particular, the risks stemming from the
type of loans they grant are the same. It follows that the REWARD that both
depositors and shareholders will want for covering that risk will be the same.

Ergo the cost of funding the
two banks is the same!!

Ergo it makes no difference
what the mix of capital and deposits is that funds a bank: the cost of covering
relevant risks is the same!

Which
is pretty much a re-statement of the Modigliani Miller theory.

Deposits, bonds and wholesale money
markets.

Having
rather suggested above that there are only two ways of funding a bank, capital
and deposits, there are of course other ways: e.g. bonds and loans from
wholesale money markets. However, the latter are essentially deposits of a
sort. Indeed loans from wholesale money markets sometimes have to be repaid in
one or two weeks, which makes them the same as retail term accounts where one
or two week’s notice of withdrawal is required.

The
word “deposit” will be used in a loose sense from now on: it covers conventional
retail deposits and bonds and loans from the wholesale money market.

The real world.

Of
course in the real world, shareholders demand a higher return than depositors
but that’s for the simple reason that depositors enjoy a cast iron guarantee
provided to a greater or lesser extent by taxpayers that deposits are safe,
whereas, while bank shareholders are subsidised TO SOME EXTENT by taxpayers,
the “cast ironess” of the subsidy / guarantee is not the same. E.G. in the UK
during the recent crisis bank shareholders took a hair-cut. Depositors did not.

In
short, FOR A FAIR COMPARISON between the costs of funding a bank via shares and
via deposits the comparison must be done on a strictly “no subsidy of any sort
is available” assumption. And on that assumption, to repeat, there is no
difference between the cost of funding a bank via capital as opposed to via
deposits.

Insolvency.

There
is however an important difference between the two scenarios. The difference
comes where it suddenly turns out that incompetent loans have been made (as
occurred with many banks at the start of the recent crisis).

In
the case of a bank funded just by deposits, ANY FALL in the value of the bank’s
assets (i.e. the loans it has made) means the bank is technically insolvent. And
if faith in the bank vanishes, a run starts, and the bank is ACTUALLY
INSOLVENT.

Alternatively,
if the bank is funded about 3% by capital and about 97% by deposits as was
common prior to the recent crisis, then assets have to fall at least 3% before
the bank becomes technically insolvent. But that’s frankly not much different
the scenario just above where ANY FALL in asset prices means technical
insolvency.

In
contrast, where a bank is funded just by capital / shares, asset values can
fall 50%, even 75% (which is practically unheard of) and the bank still isn't insolvent!
All that happens is that the value of the shares fall to about 50% or 75% of
initial value. In that sense, the bank cannot fail.

Now
in what sense is Martin Wolf right to say such a bank is “too safe”? Exactly
what is wrong with that fail safe characteristic? Absolutely nothing!

To
rephrase that, where a bank is funded just by deposits and it makes disastrous
loans, the bank collapses. In contrast, where it is funded just by shares /
capital, it soldiers on.

The “fund
by deposits” option doesn’t have a leg to stand on!

Full
reserve.

And
what do you know? A system in which lending entities are funded just by shares
is what full reserve banking involves (at least that’s what Laurence Kotlikoff’s
version of full reserve consists of). As to deposits, they are of course needed
for day to day transactions, but under full reserve, that is done with accounts
which are totally safe and involve no lending: those accounts are backed by
central bank issued money, i.e. base money.

Modigliani
Miller.

Of
course MM has been criticised. But the criticisms are feeble. See this paper of mine, section 1.4 under
the heading “Flawed Criticisms of Modigliani Miller.” Also Sir John Vickers
devotes several paragraphs to MM in a paper
published in 2012 (well after the Vickers commission final report) and suggests
a few possible weaknesses in MM, but does not seriously question it.

_________

P.S. (same day):
Another reason why bank capital may well cost more than deposits at the moment
is that bank shareholders in the US have recently had to pay around $100bn in
fines for crimes they didn’t commit: that’s Libor manipulation, laundering
Mexican drug money, etc. (Yes that’s billion, not million) The actual perpetrators of those
crimes (specific bank employees and executives) have got off Scott free. No
doubt something similar applies in the UK and elsewhere.

If
people with red cars have to pay the speeding and parking fines incurred by
owners of blue and green cars, then the cost of running a red car will be
higher than the cost of running a blue or green car. But that’s not a valid or
fair comparison of the costs of running red, blue and green cars, is it? (Sorry about the change in font size there, if you see one: this blogging system goes mad sometimes.)

Saturday, 25 October 2014

There
are two not very clued up paragraphs at the end of this article
by Positive Money. I’ve reproduced them below (in green) with comments by me
interspersed (in black).

As regards MMT, an
additional reason for their intransigence..”

What
“intransigence”? MMTers for the most part do no positively OPPOSE the aims of
PM. They just aren’t particularly interested. Economics is a big subject. MMT
takes an interest in one or two narrow parts of that subject. PM likewise. No
harm in that.

Models of
public-private sector balances were originally devised for spotting
imbalances.[10] In MMT, however, the meaning of imbalances is re-interpreted
and includes a tendency to fuse fiscal with monetary functions.

Well
PM also advocates “fusing” monetary and fiscal policy!! That is, PM advocates
that when stimulus is needed, the state should simply print more base money and
spend it (and/or cut taxes). MMTers if anything agree rather than DISAGREE with
that!!

MMTers
have never said that government can go mad and run up ever expanding and
ludicrously large amounts of debt. If any government were to do that, interest
rates would rise too far. What MMTers do say is that as long as the private
sector is happy to hold debt at a relatively low interest rate, there is no
harm in expanding the debt. And the rise in debt over the last few years has
certainly not lead to any big rise in interest rates. Indeed rates are
currently at a record low.

Warren
Mosler, a leading MMTer, takes that a bit further and advocates that government
should aim for a permanent zero rate of interest on the debt, which comes the
same thing as saying that the only liability issued by the government / central
bank machine should be base money. Milton Friedman also advocated that idea,
and I agree with it.

Moreover, government
expenditure (public-sector expenditure) is identified with sovereign-money
creation, while private payments to the public sector (taxes) are reinterpreted
as the deletion of sovereign money, analogous to paying back credit to banks.If
public debt and public expenditure equal sovereign-money creation, and if a
sovereign government allegedly can create as much of it as it deems decent,
then it seems to follow that a sovereign government is always solvent and need
not default. Deficit spending and sovereign debt thus appear to be monetarily
and financially irrelevant and economically only beneficial, while monetary
reform, again, appears to be irrelevant and unnecessary.

The
statement that a monetarily sovereign government (that’s one that issues its
own currency) needn’t ever default is correct. If it issues too much base /
sovereign money and/or debt, the result will be excess inflation and/or an
excessive rise in interest rates. But such a government needn’t ever default.

The
idea that MMTers claim that deficit spending can only ever be beneficial is
pure nonsense. The average fifteen year old who has never studied economics
knows that Robert Mugabe printed and spend far too much (i.e. ran an excessive
deficit) with the result being rampant inflation. However, MMTers DO CLAIM that
deficits over the last 5 years or so have been deficient which has led to an
unnecessary amount of austerity.

As
to the idea that MMTers think that monetary reform is irrelevant and
unnecessary, to repeat, that is not a point which many MMTers specifically
make. To repeat, monetary reform is just one of the many areas of economics
that MMTers do not take much interest in. Likewise (to repeat) there are many
areas of economics which Positive Money takes no interest in.

Thursday, 23 October 2014

The
Bank of England seems to claim that is possible. I say it’s a mathematical
impossibility under the existing system and given a bad enough bank failure.
More details are as follows.

The
Bank of England has just published a paper
entitled “The Bank of England’s Approach to Resolution” which says in the foreword
that “The Bank
seeks to ensure that firms — whether large or small — can fail without causing
the type of disruption thatthe United Kingdom experienced in the recent financial
crisis,and
without exposing taxpayers to loss.”

I’ve
only skimmed through this BoE paper, so I may be doing them an injustice, but I’m
baffled by their claim that no recourse will ever be needed to taxpayer money.

Let’s
assume a bank is funded by depositors, bond-holders and shareholders in the
ratio D, B, S.

D, B and S sum to 100% of the banks assets / liabilities.

If
the bank’s assets fall to D% of book value, then shareholders and bond-holders
are wiped out and the bank can be rescued without recourse to taxpayer’s money.
But if the assets fall to LESS than D%, and depositors are going to be fully
protected, then there is no way depositors can be saved without recourse to
taxpayers’ money.

At
least that’s the case in the UK where depositor protection is funded by
taxpayers (as I understand it). In contrast, in the US, those who deposit at
SMALL BANKS are protected by the Federal Deposit Insurance Corporation, with
insurance premiums being paid by banks.

As
to LARGE BANKS in the US, they are protected by taxpayers. Those large banks
like to argue that the recent bail out cost taxpayers nothing because all bail
out money has been repaid. However it is questionable whether those banks were
charged a realistic rate of interest for bail out money, and whether the
collateral they offered in exchange was “first class” (as recommended by Walter
Bagehot) or whether it was nearer the “junk” end of the scale.

So
how do we prevent all taxpayer support for banks? Well it’s easy: full reserve
banking.

Under
full reserve, at least as set out by Laurence Kotlikoff, entities that lend, or
the subsidiaries of banks that lend as opposed to accepting deposits, are
funded just by shareholders, or creditors who are in effect shareholders. So
given catastrophic failure (e.g. when bank assets fall to say just 10% of book
value) all that happens is that those shares fall to about 10% of book value.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

.

Bits and bobs.

.

As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

.

MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A